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The IT company's plan to sell shares in its VMware subsidiary highlights surging demand for ways to make more efficient use of computing power
So much computing power, so little of it used efficiently. That's the plight facing many corporations, their data centers jam-packed with energy-sapping servers that run corporate networks and Web sites. The good news is that a handful of companies, including EMC subsidiary VMware, are practiced at the art of better harnessing all that computing power—and cutting soaring energy bills.
Hoping to tap burgeoning demand for that art—specifically, the software at its base—EMC (EMC) plans to sell shares in VMware in the coming months. About 20,000 companies use VMware's software, which lets programs and data written for a variety of chips and operating systems run on low-cost x86 servers that use processors from Intel (INTC) and Advanced Micro Devices (AMD). That helps companies take different programs spread across a half-dozen or more servers and combine them onto a single machine. The upshot: lower hardware spending and power budgets—top of mind for cost-conscious chief information officers (see BusinessWeek.com, 11/6/06, "Coping with Data Centers in Crisis"). As a result, VMware's sales have skyrocketed, up 83% last year to $709 million, and doubling in the fourth quarter.
Demand could keep rising as EMC mines the swath of servers that don't use VMware's "virtual machine" software and as companies expand its use to wring more uptime out of their data centers amid surging Web traffic. "There's huge market potential for continuing to do what we do today," says EMC Executive Vice-President and Chief Financial Officer David Goulden.
Virtual's Big Potential
EMC wants to exploit companies' appetite for so-called virtualization by selling 10% of VMware's shares in an initial public offering planned for June or July. If successful, the IPO could generate cash for future growth, give EMC 90% ownership in a new company worth perhaps $10 billion, and help EMC boost the price of its own shares by buying back more stock.
Fewer than 10% of servers that use Intel and AMD's x86 chips—the fastest-growing part of the server market—use virtual machines, leaving lots of room for growth, Goulden says. According to market researcher IDC, the global market for virtual-machine software will grow about 33% this year, to $1.28 billion. Just two years ago, the market was worth $560 million. VMware's 2005 market share stood at 55%—and a commanding 73.5% in the x86 market.
Two trends could spark future growth, says IDC analyst John Humphreys. First is VMware's latest release, Infrastructure 3, which takes the ability to move running programs from an overloaded server to an underutilized one without interrupting users' work, and combines it with technology that can reduce servers' downtime and help them respond more quickly to electronic requests. In tandem, the technologies could help IT departments make their data centers more responsive—important as Web workloads affect more parts of computing. "That becomes a major new growth area VMware and other virtualization companies have in front of them," Humphreys says.
Second, some companies are running employees' desktop computing environments on virtual machines in a data center, instead of issuing everyone a PC. That makes repairing problems faster and cheaper. Qualcomm (QCOM), IXIS Capital Markets, and others are testing the approach, Humphreys says.
As a standalone company, VMware's value could take a giant leap from the $635 million EMC paid for it in 2004. The company could be worth $10 billion, or $4.75 a share, Bear Stearns (BSC) analyst Andrew Neff said in a Feb. 7 report. That would value the rest of EMC at $19 billion, suggesting its core storage and other software businesses are undervalued, he said. Shares of EMC closed up 90¢ on Feb. 8 at $14.50.
Taking VMware public should also help the Palo Alto (Calif.) company wage a talent war against Google (GOOG) and other Silicon Valley companies by letting it issue new stock options, says CFO Goulden. And if the IPO is a hit, it could furnish EMC with more cash to buy back additional shares from the public market, he says. EMC has committed to repurchase $1 billion worth of its own shares this year, on top of a $3.8 billion buyback last year. That could help counter the effects of a stagnant share price EMC has suffered since investors questioned the company's $2.1 billion buyout of RSA Software in June (see BusinessWeek.com, 6/30/06, "EMC's Deal Gets Dissed").
Server Rivals Not Standing Pat
But competition from Microsoft (MSFT) and open-source software players looms. XenSource has made inroads in the virtual-machine market on x86 servers, forcing VMware a year ago to issue a free version of its product, albeit absent tech support. Virtual Iron Software also sells products based on the Xen open-source project.
And Microsoft is developing new virtual-machine technology for the next version of its Windows Server operating system, code-named Longhorn. Both are due next year. Last year, Microsoft announced a technical development deal with XenSource that could let customers running Longhorn move computing workloads between those machines and servers running the open-source Linux operating system. Microsoft Senior Director Bob Visse says the company plans to give away its next-generation virtual-machine software and charge for products that help manage and secure computers that run it.
If EMC succeeds in spinning off VMware while keeping its gravy train rolling, shareholders could end up benefiting from the blue-sky scenario that has the company's executives so optimistic.